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A Theoretical Model of Financial Crisis


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  • Chan-Lau, Jorge A
  • Chen, Zhaohui


The paper develops a new model of private debt financing with an inefficient financial system at its core, where inefficiency is characterized by costly loan monitoring. The model suggests a mechanism that generates the following series of events: a period of low capital inflow despite high rates of economic growth (capital inflow inertia), as observed in the take-off era in the Asian tiger economies; followed by a sudden acceleration of capital inflow (as seen in the 1990s); and then by a crisis, which is defined as a large reduction in the amount of loans intermediated by the financial system (i.e., a large capital outflow or credit crunch). Under certain conditions, financial crisis can occur even when economic fundamentals and market sentiment change only slightly. Unlike most credit rationing models, the results presented here do not hinge on the assumption of asymmetric information. The model also provides guidance about the appropriate policy responses to an imminent crisis. Copyright 2002 by Blackwell Publishing Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of International Economics.

Volume (Year): 10 (2002)
Issue (Month): 1 (February)
Pages: 53-63

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Handle: RePEc:bla:reviec:v:10:y:2002:i:1:p:53-63

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Cited by:
  1. Berrak Buyukkarabacak & Stefan Krause, 2005. "Studying the Effects of Household and Firm Credit on the Trade Balance: The Allocation of Funds Matters," Emory Economics, Department of Economics, Emory University (Atlanta) 0510, Department of Economics, Emory University (Atlanta).
  2. Shaffer, Sherrill & Hoover, Scott, 2008. "Endogenous screening, credit crunches, and competition in laxity," Review of Financial Economics, Elsevier, Elsevier, vol. 17(4), pages 296-314, December.
  3. Alexis Derviz, 2005. "Cross-border Risk Transmission by a Multinational Bank," Working Papers IES, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies 85, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised 2005.
  4. Alexis Derviz & Jiri Podpiera, 2006. "Cross-Border Lending Contagion in Multinational Banks," Working Papers, Czech National Bank, Research Department 2006/9, Czech National Bank, Research Department.


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